Stockton mine plant 'sensible' investment: OAG

Created 24/03/14

Stockton mine's $123.6 million coal handling and processing
plant significantly contributed to Solid Energy's debt
levels, but the project was a sensible business decision,
according to an investigation by the Office of the
Auditor-General (OAG).

Its report said the plant had been estimated to cost $128m,
and funding it significantly contributed to the company's
debt levels.

The plant screened and washed coal that Solid Energy had
extracted but which was not yet suitable for sale. It
filtered waste and maximised the market potential of the
coal.

In December 2008, the Solid Energy board authorised the
plant's construction.

The OAG wanted to know whether board had enough information
to authorise the expenditure, whether it understood the risks
associated with the project, and whether it appropriately
monitored the project.

The OAG concluded management provided good information to the
board to allow it to make a fully informed decision.

Before approving the investment in the plant, Solid Energy
had carried out a pre-feasibility study and a feasibility
study.

It had obtained independent external reviews of the plant
design and cost estimates, equipment installation rates, and
contractor charge-out rates.

The board had considered the risks associated with the
project.

At each board meeting, management provided a report on how
the project was progressing. Each report discussed any issues
or "red flags" associated with the project, how management
was responding to risks, progress against schedules, and
financial costs.

Finally, Solid Energy carried out a post-investment review of
the project looking at the overall cost and actual
performance compared with that expected in the business case.

The review concluded that the final cost of the project,
$123.6m, was below the budgeted $128m.

Cash flows from the project had significantly exceeded
business case forecasts, and the "payback" for the project
was achieved in 15 months, rather than the anticipated 28
months.

The OAG was told that, without the plant, Solid Energy would
have struggled to continue to operate successfully in the
depressed coal market.

The $123.6m plant was the largest component of capital
investment in Stockton Mine during the period 2008 to 2010.

The OAG said that in its view the Solid Energy board received
the necessary information from management to appropriately
consider, approve, and monitor the project, including its
risks.

The board understood and managed those risks.

Pellet Plant

However, the OAG was less convinced by Solid Energy's Taupo
wood pellet plant, which it also reviewed because the
investment was outside Solid Energy's core coal mining
business and involved significant capital spending of $33.9m.

The OAG also found Solid Energy did not consider the
worst-case scenario in respect of coal prices.

"Solid Energy did actively consider a range of coal price
scenarios and debated these. The board and management also
reacted to changes in the coal price...But the significant
drop in coal prices in July 2012 was never anticipated, so
Solid Energy was not alone."

However, the company had a more optimistic view of future
coal prices than others in the industry.

The investment decisions made by the board and management,
and the continued operation of Spring Creek Mine, meant that
Solid Energy was not in a financial position to react to the
sharp and large drop in coal prices.

The Solid Energy experience showed the need for clear
communication between shareholders, the board and management,
the OAG said.

"We found insufficient clear communication between Solid
Energy and its shareholders. Good communication is essential
for the board and shareholding ministers to make good
decisions and for monitoring agents to provide support for
that decision-making."

The Solid Energy proposal to expand and grow its business
into a national natural resources company typified the
communication problems. The board believed the proposal was
"audacious" and put it to the shareholders for initial
review. Officials did not support this proposal, but the lack
of support was not clearly communicated to the company by the
shareholders.

"Instead, communications were interpreted by Solid Energy as
indicating that there was no support 'at that time', rather
than as a message to abandon the idea."

Good risk management also required a sceptical mind-set, the
OAG said.

"We found that Solid Energy did not give sufficient attention
to possible downside risk in its planning and forecasting.
Nor did it think about a worstcase scenario and develop a
contingency plan for dealing with the unlikely."

The board and management needed to include relevant industry
experience. From 2008 to 2012, there was only one board
member and one member of senior management with mining
experience.